§ 14. SAVINGS AND INVESTMENT.

As we have already had occasion to remark, people who are not well acquainted with economic theory are always easily inclined to exaggerate the dissensions between schools and theories and, amidst the conflict of opinions, to overlook established truths. In the sphere of trade-cycle theory no less than any other there appears at first sight to exist a hopeless muddle of opinions. This leads to the false conclusion that in this question, which has to-day become a question of vital economic, political, and cultural importance, science fails to give guidance or explanation. This conclusion, while it offers a convenient excuse for avoiding a serious study of difficult trade-cycle theory, is hasty and superficial. A closer examination reveals that from out of the conflict of the various theories of the trade cycle a common core of knowledge has gradually been built up in the course of the last decades. To this belongs especially the fundamental recognition that the real causes of the crisis must be sought not in the economic conditions of the moment of the crisis but in the mechanism of the preceding boom, and the further recognition that the mechanism of the boom culminates in an increase of capital investment financed by an expansion of credit which, via a chain of reciprocal reactions, eventually sets the whole economic system in motion. The study of the cycle leaves no doubt whatever that the swing from boom to depression is primarily a change in the volume of investment and of the production of capital goods while the production of consumers’ goods tends to be subject to smaller fluctuations. The rising curve of investment during the boom has its counterpart in the falling curve of the depression, and the more steeply inclined upwards is the first the more sharply does the second tend to slope downwards.

It is generally agreed that the real centre and root of the cycle is to be found in this rhythmical expansion and contraction of investment and the separate theories of the trade-cycle diverge from each other only so far as they give a different explanation of this rhythm. An increase of investment means the growth of the economic fabric, an increase and improvement in the productive equipment, and a step forward in economic development. So the swing from boom to depression reflects the fact that economic development does not proceed evenly but in rhythmical jumps whose force shakes for a time the equilibrium of the system so that contraction follows on the expansion. In other words, the cycle is to be considered as the typical form in which the growth of the capitalist economy takes place. In this light the crisis and depression appear as growing pains of the economic system from which we cannot escape so long as economic development proceeds by jumps instead of moving in a smooth even rise. The history of cycles and crises teaches us further that the jumpy increases of investment characterizing every boom are usually connected with some definite technical advance. In fact the beginnings of almost every modern technical achievement—the railway, the iron and steel industry, the electrical industry, the chemical industry, and most recently the automobile industry—can be traced back to a boom. It seems as if our economic system reacts to the stimulus of some technical advance with the prompt and complete mobilization of all its inner forces in order to carry it out everywhere in the shortest possible time. But this acceleration and concentration has evidently to be bought at the expense of a disturbance of equilibrium which is slowly overcome in the time of depression. This is a fundamental proposition which must be particularly stressed.

The origins of this proposition can be traced back to the early under-consumptionists (Lauderdale, Malthus, Sismondi and others). It was developed very much further by Marx. The same trend of thought has been followed up by the Russian Tugan-Baranowski⁸ who is, not quite correctly, usually regarded as the real founder of this modern over-capitalization theory. His work has been developed further with some substantial modifications by Spiethoff and from there onwards the concept has become common property through the writings of Cassel, Schumpeter, Aftalion, Bouniatian, D. H. Robertson⁹ and others.

Schumpeter lays special emphasis on the rôle of technical innovations and of the “active entrepreneurs” who do pioneer work in putting them into effect. He links up with the over-capitalization element both the technical and the psychological element. Liefmann and, most recently, Lederer also attribute an important rôle to technical progress.

If the essence of the cycle is that in the boom there takes place an over-extension of investment which is followed by an inevitable reaction in the depression, it only needs one further step to reach the conclusion that the formation of real capital in the economic system can apparently not be speeded up and extended beyond a certain limit without introducing a disturbance corresponding to the degree of “forcing.” In this sense, then, there undoubtedly exists an excess of capital formation. Since, however, the formation of real capital (investments) must be balanced by a restriction of consumption, however this may be brought about, the inference is: that the proportion between consumption and real-capital formation cannot be changed at will without causing disturbances. However desirable the accumulation of real capital may be, difficulties and possibly very serious shocks occur if the process of accumulation is forced. Up to this point there is unanimity of opinion among the greater part of trade-cycle theorists. Two further questions now arise in the answering of which ‘opinions differ. The first question is: from where does the money capital come which makes possible the investment activity of the boom? The second is: why does this increased investment activity lead to a more or less violent reaction?

A widespread theory, first represented by Tugan-Baranowski, seeks to answer both questions at once in the following manner. In the depression idle savings are accumulated as a result of the lack of attractive investment opportunities. These idle savings serve to feed the investment activity of the boom, but are at length exhausted, and the boom is then brought to an end for lack of capital. It is then revealed that the investments have been extended beyond the limits allowed by the supply of capital in the community, so that there has to take place a painful process of recession. According to this theory, there corresponds to the change in investment activity, and therewith from boom to depression, a change also from a superabundance to a shortage of capital.

In this theory which, under the designation of the “shortage of capital theory,” is the most popular theory among the more intelligent sections of the business world and among journalists, the one point is certainly correct: that the changing proportion between saving and investment—an excess of saving over investment in the depression and an excess of investment over saving in the boom—is a decisive factor. It is also true to a certain extent to say that a storing up of “capital” takes place in the depression corresponding to the extent to which the rate of saving surpasses the rate of investment. This has more than once been disputed and it has been quite mistakenly supposed that all that is saved in the depression is also invested. Even quite apart from the fact that in the depression people are disposed, out of mistrust, to estimate cash more highly, and apart from the rise in cash reserves (slowing up of the velocity of circulation), a storing up of money capital can take place by way of savings being accumulated as bank deposits instead of being invested in securities. This is equivalent to a sterilization of purchasing power in so far as the banks have to hold liquid reserves against the money deposited with them and are particularly anxious to keep liquid in the depression.

Investments abroad also represent some reserve of power which accumulates in the depression ready for the boom, but only with certain reservations. It has also been supposed that there were stocks of goods corresponding to the stored-up money capital and that these stocks of goods supplied the real bases of the expansion of production in the boom. In fact, however, commodity stocks tend to be particularly low at the end of the depression.

The storing up of money capital during the depression is, then, an undeniable fact which furnishes an important elucidation of the depression. But it would be totally wrong to suppose that these accumulated reserves could contribute substantially towards fostering the heavy investments of the boom years. The conclusion is that the means of financing the boom can only be derived in the main from the boom itself. Its sources are increased savings during the boom period and, above all, additional credits (credit expansion). The inference from this is a further extremely important proposition to which we shall often have occasion to revert in the next paragraphs. In any case it disproves this part of the theory of alternating superabundance and shortage of capital.

We turn now to the contention often denominated as “the ruling theory of the trade cycle” that the cause of the crisis and depression is the shortage of capital setting in at the end of the boom period. Superficially considered, this is correct, but it offers no real explanation, since the shortage of capital is not a new independent element but a result of the whole mechanism of the boom. The shortage of capital is the signal for the breakdown, but it is made inevitable by the over-expansion of investments. If the emphasis is laid on the shortage of capital it gives the impression that a further increase of the supply of capital could avert the turn. But if the increase of investments has taken on pathological dimensions a further increase of capital can only postpone the turn and this only at the expense of a later and all the more severe reaction. The shortage of capital at the end of the boom period is a sign that the credit system has put its last reserves into the firing lines in order to support the wavering front. The scale of investments at length even outgrows the framework of capital creation artificially extended by the expansion of credit. To use a simile, those who lay the main emphasis on the shortage of capital as the factor turning the boom into depression may be compared to some well-known politicians in Germany after the war, who used to say that the defeat could have been avoided if the people had shown more military strength instead of “stabbing the army in the back” by its defeatist spirit. It would have been excellent, of course, for Germany if, at the end of the war, she could still have had the armies and the spirit of 1914, but this is absolutely beside the point because it was precisely as the result of four years of war that Germany was down and out, and any effort to make possible the impossible would only have delayed the ultimate defeat at a terrible cost. It would be a grave injustice to accuse the German people of a lack of spirit of sacrifice instead of accusing the length of the war and its ever-growing dimensions. We may conclude, then, that the emphasis must be laid not on the supply of capital, but on the demand for capital. The evil is not that too little has been saved but that too much has been invested. The shortage-of-capital theory distorts, therefore, the causal sequence, limits itself to the surface and places the accent in the wrong place.

We answered the first question, as to the origin of the money capital which nourishes the boom, mainly by pointing to the rise in the supply of capital which comes about during the boom via increased savings and, above all, via additional credits. To the second question as to what causes the breakdown of the over-investment, we have yet to give a satisfactory answer. We shall try to give a summary of the most important points to be taken into consideration.

Firstly, it should be clear that the total income of a community is allocated partly to direct consumption and partly to saving, and that the total production is devoted partly to the production of consumers’ goods and partly to the production of capital goods. Now it is essential for the equilibrium of the economic system that the composition of production (out of which income is created afresh) should correspond to the manner in which the public spends its income. If the proportions between the production of capital goods and the production of consumers’ goods correspond to the proportions in which the public saves and spends its income respectively, then the economic system is in a state of equilibrium.

Now, if the savings proportion is in any way suddenly and substantially raised, the equilibrium between the composition of production and the allocation of income is disturbed. The usual way in which a sudden increase in the amount of savings of the community takes place is the following: an increase in investment is the primary factor and it is by a roundabout process of the expansion of credit that this induces an increase in the volume of savings of the community leading to complications in our formula which cannot be gone into in more detail here. The increase of investment then goes on rising by its own force, since the expansion of capital investment brings more and more new orders to the capital-goods industries. The scale of investment grows, and so long as the rate at which it grows remains constant, or even increases, the boom has the power to last. Eventually, however, the moment must come when investment is not suddenly broken off certainly, but ceases to grow at the previous rate. We cannot always be building and “rationalizing” further, always constructing new electricity works or railways and installing new machines; especially as the power of the credit system to go on continually financing this investment delirium is finally exhausted. At this point the boom must come to an end since a shrinkage of the capital-goods industries is unavoidable. Whether the breakdown takes the form of a crisis or of a gentle transition to the depression depends on the circumstances. We shall see the process more clearly if we reflect that a boom in, say, poultry or silver-fox farming is also for some time self-maintaining, that is, so long as new farms are continually setting up and exercising a demand for breeding stock. But, finally, the moment comes when the establishment demand for fowls or silver-foxes is satiated. Then it appears that the fowl or silver-fox production is greater than corresponds to the normal requirements for consumption and breeding purposes. This will become apparent immediately the number of farms ceases to grow at the former rate. It is evident that once the fowl cycle is set in motion the breakdown is unavoidable. According to the shortage-of-capital theory, it is possible to postpone it by the stimulus of continually providing capital for the setting up of poultry farms, but it is obvious that this only magnifies the avalanche. Just as we cannot continually pursue fowl production for the sake of producing more fowls, no more can we eternally produce capital goods for the purposes of producing more capital goods. Since after a certain time the latter in their turn produce more capital goods, such an insane economic system can only go on so long as the scale of the production of capital goods is continually expanded. In other words: sooner or later the end must come and it is all the worse the further the scale of investment has been pushed.

This self-inflammatory character of any rise of the rate of investment due to the mechanism of intensification described above (“principle of acceleration”) has been stressed by many trade-cycle theorists (Aftalion, Bouniatian, Bickerdike, Carver, Marco Fanno and especially by J. M. Clark¹). As it is of the greatest importance for a better understanding of the whole process of the business cycle, something more must be said in order to make its meaning quite clear. From the examples given above, it will be easily grasped that any increase in general economic activity will have the tendency to produce a disproportionate expansion in the higher stages of production, the rate of expansion being the greater the higher is the stage of production, i.e., the further it is removed from the sphere of consumption. The opposite is true for any decrease of general economic activity.

The reasons for this intensified impact on the higher stages of production are twofold : (1) In the absence of excess capacity any increase of the productive equipment of the country necessitates a further increase of the productive equipment in order to produce the initial increase (as in the example of the poultry and silver-fox farms). In order to produce more machinery the machine industry itself has to produce more machines for producing more machines; an enlargement of the cement factories calls forth not only an increased demand for building the additional cement plants, but also an increased demand for enlarging other factories delivering the equipment of the additional cement plants and so forth. (2) Assuming that in all stages of production and distribution a certain fixed percentage of sales is held as stocks, any increase of general economic activity (as measured by the volume of sales or goods produced) will bring forth an increase of orders greater than the initial increase of sales. If the demand for shoes increases, dealers will place orders equivalent to the aggregate of additional sales and additional stocks, and the same thing will be repeated in the higher stages on a progressively rising scale. But this whole machinery of increasing intensification will stop the moment the increase comes to an end. In substance, this process of intensification by the enlargement of stocks of working capital amounts to the same thing as the process of intensification by the enlargement of the productive equipment (fixed capital). In both cases the increased volume of production in the upper stages can be maintained only if the increase of demand in the lower stages goes on at the same rate. It is, therefore, not sufficient that the demand does not decrease absolutely, nor even that it continues to increase if only at a lower rate; for the maintenance of the top-heavy superstructure of production, it is necessary that the ultimate demand should rise at the same rate or, in other words, in geometrical progression.

This proposition is, however, subject to a number of qualifications: (1) If capital equipment is being continuously increased, a secondary demand is thereby created which is not dependent on a continuous and progressive increase of ultimate demand but only on its steady level. This secondary demand is the demand for the replacement of durable means of production which is bound to develop as time goes on and so partly to take care of the problem of how the top-heavy superstructure can be permanently maintained. It is conceivable that, under certain circumstances, this factor may serve as a parachute for the blown-up structure of production, the decrease in new construction being compensated to a considerable extent by the increase in replacement demand. But the peculiarities of the business cycle do not make it very likely that this will happen. Apart from the fact that the top-heaviness of the structure of production is usually much too great at the end of the boom to be relieved in this manner, the replacement demand is itself highly elastic and subject to the mass psychology of the different phases of the cycle. As it is, this factor is apt to work in a direction inverse to what is desirable for the purpose of compensation. For it is precisely during the boom period that replacements are speeded up, and it is precisely during the depression that replacements are postponed as long as possible. In both cases, this factor acts to intensify rather than to attenuate the violence of the movements. It is a well-known fact that the intensity of the present depression owes much to the circumstance that the replacement demand has been reduced to the utmost minimum. (2) Account has to be taken of the possibility that, on the average, stocks may not rise in proportion to the growing volume of sales and of goods produced during the boom, nor decrease in proportion to the decreasing volume during the depression. If that is the case, they will also serve as a compensating element. But it is again very unfortunate that just the opposite is probable, in view of the fact that rising prices (boom period) may induce the carrying of larger stocks and vice versa. Though we cannot be so sure in this case as in the case of replacement demand, it will not be an error to assume that the varying volume of stocks is an intensifying rather than a compensating factor. How both factors can work together, bringing about disastrous results, may be gathered from the fact that in the United States the production of automobiles (a durable consumption good to which the same principles must be applied) decreased from 5,621,715 in 1929 to 1,431,494 in 1932, while the number of registrations declined only from 26,545,281 to 24,136,879. Thus a decline of nearly 75 per cent. in annual production corresponded to a decline of only a little over 9 per cent, in the total number in use.² (3) A very important qualification must be made with regard to the possible existence of excess capacity and of surplus stocks during the upward-swing of the cycle. As long as the increase of general economic activity can be based on excess capacity and surplus stocks, the mechanism of intensification will not begin to work and so the otherwise unavoidable reaction may be avoided. Now, this is not a mere hypothetical assumption. It is usually the actual situation during the first stage of the upward-swing, though not so much for surplus stocks as for excess capacity. This is one of the main reasons why the upward-swing of the business cycle must be sharply divided into two phases, the first being of a compensatory and balancing character, the second of a self-inflammatory and unbalancing character.

Particular importance is, moreover, to be attached to the circumstance—which D. H. Robertson and Aftalion especially have emphasized—that the expansion of the productive equipment takes time. Before the products of the expanded productive equipment come on to the market and flood it, several months elapse during which the over-investment may develop to gigantic dimensions unobserved. It is evident that the length of the boom is connected to some extent with the period of time necessary for the construction of the productive plant—the “period of gestation” in Mr. Robertson’s terminology.

Over-investment, conducive of general economic disequilibrium, may develop in any economic system, provided that the volume of “saving” (in the broadest sense of a relative curtailment of current consumption, i.e., “lacking” in Mr. Robertson’s terminology)³ is allowed to expand, in quantity and in speed, at a rate which is no longer compatible with economic equilibrium. There is no maximum rate of saving as such which must not be exceeded if disequilibrium is to be avoided. In this long-run sense a problem of “over-saving” certainly does not exist. But a problem of “over-saving” does appear if the rate of saving rises so suddenly and in such a degree that it leads to over-investment. The balancing forces of the economic system can take care of a rise of the rate of saving if it does not exceed a certain maximum of speed and quantity; beyond that point the equilibrium will give way.⁴ The question then raised is this: how is such a sudden and substantial rise in the rate of saving conceivable in our economic system?

In answering this question, the crucial point is that the normal source for the formation of capital in our economic system, viz., voluntary savings by individuals laying aside a part of their incomes, is unlikely to give rise to a sudden and substantial increase in savings. It has to be observed, however, that once the up-swing of the cycle has been started certain forces are set in motion which stimulate a substantial increase of voluntary savings. Apart from the favourable effect of the increase in the national income on the volume of savings during the up-swing, we have to recall what has been said in § 12 about the change in the social structure of incomes during the up-swing, a change characterized by an expansion of profit incomes and variable incomes relatively to fixed incomes. This change is equivalent to a rise of those incomes which are more liable to be saved rather than spent. In addition to this, account has to be taken of the large corporate surpluses (entrepreneurial formation of capital or “self-financing”) which are apt to develop during the boom, adding enormously to the aggregate of savings. This source of saving has risen to prime importance during the last decades along with the development of industrial monopolies and large corporations, with the policy of stabilizing dividends, and with certain degenerate tendencies in the financial structure of industry and banking.⁵ The importance of this factor is enhanced by two further circumstances: (1) corporate surpluses are usually larger in the industries producing capital goods than in those producing consumption goods so that the tendencies towards over-investment are accordingly reinforced; (2) corporations have a well-known inclination to reinvest their surpluses in their own plants instead of investing them on the general capital market so that the rate of interest has to this extent lost its regulating influence.⁶ This tendency, since it leads to over-expansion in special trades (for instance, the copper industry in the United States or the cement industry in Germany after the war) reveals an additional source of trouble. So we see that the entrepreneurial formation of capital (corporate surplus) may become an important means of enlarging the aggregate of savings and contributing to a tendency towards over-investment.⁷

But even this, I think, is not sufficient to raise the rate of saving so suddenly and so substantially as regularly to set in motion the process of over-investment. There are, moreover, other characteristics of the boom which, being of a monetary nature, cannot be explained in this way. I would concede that this factor, like the change in the social structure of incomes, is of great importance for reinforcing the process once set into motion, but not more. I believe that the rise of savings and investment brought about by these two factors will generally be capable of assimilation by our economic system without leading to grave maladjustments in the system as a whole. In order to reach dimensions liable to break up the economic equilibrium, savings and investments must be forced up by a more powerful mechanism. For this it is necessary that some kind of coercion be exerted which releases the production of capital goods from the link with the community’s voluntary decisions to save, and forces the proportional shrinkage of the production of consumption goods above the level to which the community is prepared to submit voluntarily through its savings. This coercion may take place with the brutal overtness of Russia to-day under the rule of the Five-Year Plan which represents to the trade-cycle theorist a gigantic attempt with the aid of government authority to free the tempo and extent of investment from the limitations imposed by the rate of savings—consumption being ruthlessly held down by means of State force. This throws further light on the probability mentioned already that in Russia also the steepness of the investment curve will find its counterpart in the sharp descent of the curve of reaction, only with the difference that the reaction in Russia will assume other forms than in the capitalistic countries. It is in any case useful to realize that what is being carried out in Russia differs from the type of boom characterized by overcapitalization in the capitalist countries in method and extent only, and not in kind, and bears a likeness to it even so far that all warnings of an inevitable reaction are thrown to the winds. In the capitalist economy the place of authoritarian force is taken by credit expansion.

As will be seen in the next section, the expansion of credit also involves “forced saving,” though of a totally different kind. The difference may perhaps be expressed by saying that in our economic system it is monetary “forced saving” which sets the wheels of over-investment in motion, while in Soviet Russia it is authoritarian “forced saving.” Whereas in Russia the coercive machinery is represented by the G.P.U. with its rifles and dungeons, in capitalism it is represented by the banking system with its cheques and overdrafts. This capitalistic machinery of credit expansion serves two purposes: in the first place, it provides the entrepreneur waiting to invest with the necessary additional credit and, in the second place, by raising profit expectations, it increases the desire to invest, of which the driving force is here, in contrast to the socialist State, governed by individual decisions based on profit expectations. This is, in fact, the way in which the process of cyclical movement regularly takes place in the capitalist world.

In the foregoing analysis, the reader has been, as far as possible, spared any allusion to the fierce controversy at present raging round many, if not most, of the points discussed above. This controversy has become so highly technical and, to a large extent, even confused, that some detachment from it, at least for the moment, would seem to be indicated in order to regain clarity on the main issues, even at the cost of some over-simplification here and there. At this juncture, however, it becomes indispensable to compare our results with certain other theories of the present time and to attempt, if necessary, some classification. The point of view of the present author will, perhaps, become clearer in consequence. With this end in view, it will suffice to mention two theories which, seeming to a large extent mutually exclusive, have lately become more and more the centres of discussion : the theories of J. M. Keynes and F. A. von Hayek.

The central theses of Mr. Keynes,⁸ which he develops by the aid of a number of ingenious though debatable equations, runs as follows: The real sources of rhythmic disturbances are not changes of the rate of saving or of the rate of investment but recurrent discrepancies between the two rates, in such a way that a rate of investment greater than the rate of saving engenders the boom, and a rate of saving greater than the rate of investment engenders the depression. Equilibrium can be maintained only by the equality of the rates of saving and of investment, but this is also a sufficient condition. Of these two rates the rate of saving is more steady in character, while the rate of investment, is subject to jerky fluctuations. The essence of his theory is given by Keynes in this classical passage⁹ : “It is enterprise which builds and improves the world’s possessions. Now, just as the fruits of thrift may go to provide either capital accumulation (if savings are invested—R) or an enhanced value of money-income for the consumer (if savings are not invested—R), so the outgoings of enterprise may be found either out of thrift or at the expense of the consumption of the average consumer. Worse still;—not only may thrift exist without enterprise, but as soon as thrift gets ahead of enterprise, it positively discourages the recovery of enterprise and sets up a vicious circle by its adverse effects on profits. If Enterprise is afoot, wealth accumulates whatever may be happening to Thrift; and if Enterprise is asleep, wealth decays whatever Thrift may be doing. . . . Now, for enterprise to be active, two conditions must be fulfilled. There must be an expectation of profit; and it must be possible for enterprisers to obtain command of sufficient resources to put their projects into execution. Their expectations partly depend on non-monetary influences—on peace and war, inventions, laws, race, education, population and so forth. But . . . their power to put their projects into execution on terms which they deem attractive, almost entirely depends on the behaviour of the banking and monetary system.” To this the present author would whole-heartedly subscribe, adding that it contains a truth which could hardly be put more eloquently. When Keynes makes the rise of the rate of investment above the rate of saving (which, in his definition, excludes “forced saving”) responsible for the boom, he says essentially the same thing as was said in the course of our preceding analysis where it was stated that it is usually the adding of “forced savings” to normal saving which raises investments to a dangerous height. Though the practical result is the same, the approach is different, since in our analysis it is not the rise of the rate of investment relative to the rate of saving which is the real cause of instability but the absolute rise of investments no matter whether financed by voluntary or forced savings. For all practical purposes this amounts to the same thing, so far as the explanation of the capitalistic boom is concerned.

But the different approach of Keynes has two consequences. The first consequence is that in his analysis the main emphasis is put on a point which, under certain circumstances (i.e., when the absolute rise of investments is not brought about by a disparity between savings and investments, or, that is, by credit expansion), may be only of minor importance. So Mr. Keynes has little to say about the general possibilities of over-investment engendered by the acceleration principle, especially in a socialist system. This point is connected with the second consequence of the Keynesian approach that, making no use of the acceleration principle, he is rather vague about the disruption of the structure of production by over-investment and is evidently inclined to deny the necessity of a painful process of readjustment brought about by the crisis. This seems to me the weakest point in the whole analysis of Mr. Keynes. Where he comes out strongest, on the other hand, is in his analysis of the cumulative process of depression which, in my opinion, can indeed be no better stated than in the terms of the saving-investment approach elaborated by him. It seems to me that this is the main and the most valuable contribution of Mr. Keynes which can and must be highly appreciated even by those who prefer other explanations for the boom period.

Just the opposite is true in the case of the equally important contributions to the problem of crises and cycles of Dr. v. Hayek.¹ As far as the explanation of the depression is concerned, Dr. v. Hayek’s endeavours seem to be unsuccessful to the point of being positively misleading, but his analysis of the boom period on the other hand contains elements which represent a real advance. The gist of his theory is that, while any amount of investments financed out of voluntary savings tends to leave the structure of production intact, it is a rise of investments financed out of forced savings which puts the structure of production out of balance so that a subsequent readjustment becomes inevitable. We cannot enter here into the very intricate details of his reasoning which are connected up with some rather controversial propositions of the theory of capital of the Viennese school (Böhm-Bawerk, Mises, Strigl² and others). Let it suffice to remark that, by emphasizing the rôle of forced savings (credit expansion) as the driving force of overinvestment, Dr. v. Hayek’s theory amounts, in the last analysis, to the game thing as Mr. Keynes’ theory and our own analysis, at least for all practical purposes. But below the surface there are substantial differences. In our analysis, over-investment by forced savings appears as the special form in which, in our present economic system, the general source of instability, i.e., over-investment no matter how financed, becomes a practical possibility. In Dr. v. Hayek’s analysis, over-investment by forced savings appears as the sole case in which over-investment as a factor of instability is conceivable. To be more explicit, we must say that, in Dr. v. Hayek’s view, the real source of trouble is not too much investment, but too little voluntary saving.

Dr. v. Hayek’s theory is, indeed, the most uncompromising example of an under-saving theory of business cycles. The same amount of investments which, if financed by forced savings, spells disaster would, according to this theory, be harmless if it were financed by voluntary savings or even if the forced savings were replaced later by voluntary savings. In our view, it is the steep rise of the absolute amount of investments which matters, not the fact that our economic system must rely on credit expansion to make this rise possible. In our view, therefore, even a socialist state has to face the same problem if investments are sped up by authoritarian forced savings, a statement which is contrary to Dr. v. Hayek’s analysis. He must, consequently, hold the belief that a socialist system is not exposed to this kind of disturbance. But there are other consequences too. While in our analysis the ultimate breakdown of the boom is explained by the acceleration principle, in Dr. v. Hayek’s theory it is the shortage of capital which puts an end to the boom, and this shortage of capital must come sooner or later if investments are being financed by credit expansion. He makes no use of the acceleration principle, and even rejects it, explicitly, by saying that the top-heavy structure of production could be maintained if so much more were saved as to increase the capital equipment in the higher stages to such a magnitude that its replacement demand would use fully the capacity of the lower stages.³ But since it is indisputable that the top-heavy structure has been brought about by a general rise of investments no matter how financed, it is difficult to understand how more savings and more investments could restore the balance instead of postponing the ultimate breakdown at the cost of intensifying it. In this sense, the shortage of capital at the end of the boom is an indubitable calamity, but, as was said earlier in this section, it is no real explanation, since it is the inevitable result of the whole process of the boom. All this is, it must be repeated, a philosophy slightly reminiscent of the legendary “victory at arm’s reach” and “dagger-stab in the back” in Germany after the war.⁴

Though this and a number of other propositions are highly debatable the merits of Dr. v. Hayek’s work can hardly be overrated. He has given a new stimulus to economic thinking on all these problems by diverting attention to questions hitherto unseen and by the brilliance and profoundness of his attack,⁵ even in those points where his analysis is the most provocative of contradiction.